“April I would view as largely bankable at this time, and I think that May may very well hold a follow up rate hike,” Hall says. “For a year end target, I’d lean towards the 4.5% level. We can’t lose sight of the fact that the economy is at full capacity.”
Even at this rather modest level, Hall almost stands out as a doomsayer. In a March 7 research note, CIBC economist Avery Shenfeld agrees that the Bank will raise rates in April, but predicts that “the end is nigh” for Canadian rate increases. TD deputy chief economist Craig Alexander is also predicting the overnight rate will peak at 4.0% by end of year.
Almost all commentators agree that the size of the March increase was less important than the language of the announcement, as Bank Governor David Dodge replaced the word “would” with “may” when referring to future rate hikes.
A rate of 4.5% - the “worst case scenario” presented by Hall’s forecast - is still fairly benign. So what’s behind his thinking?
Hall expects the BOC will keep pace with the U.S. Federal Reserve (FED), which he says has adopted a more data-driven approach to rate hikes. In the past, the Fed had taken a more “mechanical” tack, hiking rates by 25 points at each meeting just to raise them out of the gutter.
“There is considerable room for economic optimism going into the Bernanke FED (Ben Bernanke replaced long running FED chairman Alan Greenspan in February) that would justify continued rate hikes,” Hall says. “He is largely responding to the economic fundamentals that are out there.
“If the Fed is continuing with its rate cycle, there's arguably room there for the BOC to continue hiking rates as well," Hall says, and he predicts a Fed funds rate of 5.5% by August.
While Canadian interest rates will remain low by historical standards, there is some fear that consumers may have already forgotten what high interest rates look like. A bank rate of 4.5% is still quite accommodative, especially when compared to the rates in the 1980s. Only time will tell if consumer psychology – and spending – can withstand even this modest rate hike.
“I am concerned that monetary policy left overly accommodative for an extended period is damaging,” he says. “There is the threat that you end up with a consumer who is unbalanced.”
The problem facing the Bank of England, for example, is that higher interest rates were effective in slowing the economy, but had the undesirable side effect of hurting the debt-laden consumer.
With interest rates expected to only rise by another 75 basis points by year end, there is probably no need for panic among homeowners with adjustable rate mortgages. Research has shown a floating rate costs less than a fixed rate mortgage over 90% of the time frames examined.
The real question lies not with rising rates, but with the individual borrower’s risk tolerance. If the mortgage holder’s financial footing is no worse than in the past, they should probably stick it out with the floating rate. If they have become less certain about their personal finances, they may want to opt for the predictability of a fixed rate mortgage and lock in now.
More worrisome is the consumer savings rate. Traditionally, Canadians have been a rather thrifty lot, with double-digit savings rates in the not too distant past. But record low interest rates unleashed pent up demand, as the cost of financing purchases plummeted. In 2005, the savings rate fell into negative territory, to -0.2%, from an already low +1.4% in 2004.
“These very accommodative rate structures are encouraging the consumer to spend and leverage themselves at the expense of savings,” Hall says. “We really can’t blame the consumer for doing that, because they are simply following the pricing signals that tell them ‘money is cheap.”
If consumers are worrying about interest rate increases, a good first step would be to pay down their high interest debt first, such as credit cards and other loans they may have, before worrying about their mortgages
